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China’s lust for iron ore hits the rocks in the outback

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SINGAPORE Sinosteel Corp., one of China's largest natural resource companies, might be thinking twice about getting embroiled in one of Australia's longest-running soap operas.

The Beijing-based company looked like a safe bet to complete what would have been China's biggest overseas mining investment to date by snatching up iron ore junior Midwest Corp. Ltd., West Perth, Western Australia.

For years, Midwest and counterpart Murchison Metals Ltd., also based in West Perth, have been flirting with a possible merger/takeover deal. But Murchison dropped its takeover proposal earlier this year, saying there was no chance of a good deal for shareholders.

The strategy looked safe rival Australian suitor Murchison Metals had backed off and Sinosteel managed to persuade the Midwest board to agree to a bid after some initial resistance. End of story, right?

Not quite. Having previously concluded that a good deal was impossible, Murchison returned to the fray and put together a reverse takeover deal that would cut out the Chinese. Sinosteel said it wouldn't raise its cash offer, but Midwest hasn't quite made up its mind.

On the morning when Murchison announced its new bid, Midwest ended up in the position of recommending both offers while it waited for the market to react.

Why is all this important?

When Sinosteel made its original bid, it was hailed as the first in what would be a tidal wave of Chinese investment in the Australian iron ore sector. China has a huge appetite for Australian iron ore, and a large portion of the new iron ore supply to come on-stream in Australia during the next five to 10 years is already committed in one way or another to the Chinese.

Take Fortescue Metals Group Ltd. (FMG) in East Perth, Australia, for example. The launch of its first shipment was attended by the head of Baosteel Group Corp., China's biggest steelmaker, which has agreed to buy up much of FMG's supplies. There are many such offtake agreements across the Australian industry.

For a variety of reasons, however, question marks remain regarding the wisdom of Chinese direct investment or equity ownership of Australian iron ore companies. Certainly, there is political nervousness in Canberra, Australia's capital, about selling off valuable national resources to the Chinese. Any Chinese company wanting to get control of an iron ore producer in the remote Pilbara region can expect some lengthy stays and a robust grilling by the country's Foreign Investment Review Board. Much is made of the political character of Chinese resource companies. Sinosteel is being lined up for a significant share listing, but remains state-owned for now.

One way for Sinosteel to outmaneuver Murchison would be to draw on vast reserves of cash that everyone assumes the Chinese government can put at its disposal. That could happen, but there are many voices in China urging caution getting control of overseas iron ore might make strategic sense, but it shouldn't come at the expense of value, or at the risk of sparking political squabbles.

Some analysts in China are contend the country's resource-hungry industry would be wise to exercise restraint, especially because the iron ore supply-demand future is uncertain. There are so many projects planned—and not just in Western Australia—that China could need fewer captive resources in years ahead as prices fall.

Indeed, the iron ore market is already throwing up some surprises. Despite all the talk in the past year of the extremely tight spot market driving up prices, and a 65-percent increase in annual benchmark prices this year, headlines are suddenly reporting a massive buildup of iron ore clogging China's ports. About 80 million tonnes has accumulated, mostly because speculators saw prices going sky-high and tried to get their hands on as much material as possible but then discovered that maybe the market wasn't as strong as everyone said it might be.

The Chinese steel industry association has ordered buyers to focus on shifting existing ore rather than purchasing more material. (This happens to tie in with separate calls for importers to stop buying spot iron ore from Rio Tinto to protest the latter's lack of commitment to contract shipments—yet another sign of the uneasy relationship between the Chinese steel and Australian iron ore industries.)

Certainly, clampdowns on steel production in China ahead of the Olympic Games aren't helping demand, but mills there are also are facing a credit squeeze, which isn't likely to end while the Beijingtries to rein in liquidity pressures.

At the very least, all this demonstrates that the future is uncertain and Chinese companies are going to be very careful about storming into the Australian iron ore sector simply because it seems like a good idea right now.

There is talk of other deals—notably surrounding Aurox Resources Ltd., Subiaco, Western Australia, one of the brighter prospects in the Australian iron ore industry—but it remains to be seen whether the wave of hostile takeovers that Sinosteel's initial bid was supposed to herald will actually materialize.

Either way, the importance and symbolism of the Murchison-Midwest-Sinosteel tussle is inderscored when you consider what they're actually fighting over is the ownership of a company that plans to produce 1 million tonnes a year of iron ore.

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